Grand Mal Economics

Industrial market economies have been suffering from periodic financial crises, followed by high unemployment, at least since the Panic of 1825, so we have had nearly two centuries since then to figure out how to deal with them. Why, then, have governments and central banks failed this time around?

BERKELEY – Across the North Atlantic region, central bankers and governments seem, for the most part, helpless in restoring full employment to their economies. Europe has slipped back into recession without ever really recovering from the financial/sovereign-debt crisis that began in 2008. The United States’ economy is currently growing at 1.5% per year (about a full percentage point less than potential), and growth may slow, owing to a small fiscal contraction this year.

Industrial market economies have been suffering from periodic financial crises, followed by high unemployment, at least since the Panic of 1825 nearly caused the Bank of England to collapse. Such episodes are bad for everybody – workers who lose their jobs, entrepreneurs and equity holders who lose their profits, governments that lose their tax revenue, and bondholders who suffer the consequences of bankruptcy – and we have had nearly two centuries to figure out how to deal with them. So why have governments and central banks failed?

There are three reasons why the authorities might fail to restore full employment rapidly after a downturn. For starters, unanchored inflation expectations and structural difficulties might mean that efforts to boost demand show up almost entirely in faster price growth and only minimally in higher employment. That was the problem in the 1970’s, but it is not the problem now.

J. Bradford DeLong is Professor of Economics at the University of California at Berkeley and a research associate at the National Bureau of Economic Research. He was Deputy Assistant US Treasury Secretary during the Clinton Administration, where he was heavily involved in budget and trade negotiations. His role in designing the bailout of Mexico during the 1994 peso crisis placed him at the forefront of Latin America’s transformation into a region of open economies, and cemented his stature as a leading voice in economic-policy debates.

Can it be that a new near collapse of a central bank is what is needed to cure the grand mal? In fact we have one recent example, from 2008, when the central bank of Iceland collapsed after having supported the banks too much. There are lessons from it that might be useful for other countries in the North Atlantic region, even though they have not as big banking system, proportionally, as the the small island in the middle of the North Atlantic.

"The United States’ economy is currently growing at 1.5% per year (about a full percentage point less than potential)"

- Sorry Mr. DeLong, Economy seems to disagree with you by growing 1.5% less than you expect it to grow.

"Over the following century, economists like John Stuart Mill, Walter Bagehot, Irving Fisher, Knut Wicksell, and John Maynard Keynes devised a list of steps to take in order to avoid or cure a depression."

- Has it occurred to Keynesians that at zero interest rate, value of any risk free investment with any rate of return is theoretically infinite; so assets can suck in all the liquidity - which is supposed to have driven goods and services sectors?

Hey ... but maybe it's actually the repeated interventions from government to lower interest rates, print money, and guarantee and protect the "good guys" which makes increasingly unstable deleveraging cycles necessary in the first place? Just saying.

Maybe these pro gov intervention economists are looking for some taxpayer payola for their academic tenure.

Maybe if the banks, who have the most to lose and and had the most interest in preventing their money being lost, were allowed to decide interest rates, and not forced to buy junk gov deficit spending, then maybe this wouldn't happen.

Maybe you just can't outsmart the economy but trying out new tricks to get something for nothing.

The best example of 'prolonged liquidation' is Japan, where for almost a decade monetary policy has stayed near zero lower bound, thus making debt more attractive than money; the zooming of debt to GDP ratio, while it was zooming had no direct correlation with job growth while prices have stayed dampened throughout. If this is a successful model to emulate, then so be it, specially when demographics would further come in the way of providing solutions, as is the case with Japan.

We have seen how monetary transmission beyond a point has its limits to move into goods and services that create jobs; rather it moves to inflate some assets at the cost of the other; a retraction or contraction or the dozing amount makes this movement oscillatory.

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